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Payout ratios can be a good start in your investigation of a company’s dividend safety. But which one should you use? What’s a good payout ratio and what does it tell you exactly? This is what you’ll find out today!
Become a master of payout ratios, listen now!
You’ll Learn
- Why the number of a payout ratio doesn’t mean a thing without the trend.
- What is a good payout ratio?
- What does a negative payout ratio means.
- Is it true that a payout ratio over 100% is not good.
- What’s the Cash Payout Ratio, the Distributable Cash Flow Payout Ratio (DCF), the FFO/AFFO Payout Ratio and when to use them.
- What are the pros and cons of each payout ratio.
- How can you use payout ratios to protect your dividends.
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As promised in the episode, here is a summary of each payout ratio. You will find the formula, its utilization as well as its pros and cons. These were found in the DSR Glossary & Terms, an exclusive section to members of Dividend Stocks Rock.
Dividend Payout Ratio
Formula: Dividend per share (DPS)/Earnings per share (EPS)
Utilization: Classic methodology (regular companies)
It’s preferable to look at a 5 to 10 years trend and look at quarterly earnings when there is an important fluctuation.
Pros: Commonly used and easy to understand.
Cons: Earnings are calculated by using generally accepted accounting principles, and it does not reflect the cash the company really has on hand to pay its dividend. It must be combined with other metrics during an analysis.
Cash Payout Ratio
Formula: Dividend Paid/Cash Flow from Operation – Capital Expenditure – Preferred Dividend Paid
Utilization: Classic methodology (regular companies)
It’s preferable to look at a 5 to 10 years trend and look at quarterly earnings when there is an important fluctuation.
Pros: It gives a clear picture of the company’s ability to use its cash resources to pay their dividend. It’s more precise than using earnings.
Cons: It is also more complicated to calculate. Capital expenditures (CAPEX) are also often financed by debt and do not require cash flow from operations. Therefore, you must look at how much CAPEX the company has each quarter to determine if the cash payout ratio is high or not.
Distributable Cash Flow Payout Ratio
Formula: Dividend per share (DPS)/Distributable Cash Flow (DCF) per share
Utilization: Pipelines or utilities.
This metric is often provided directly from the company itself with a detailed calculation.
Pros: Similar to the cash payout ratio where you get a clear picture of how much the company has in cash to pay dividends.
Cons: In most cases, you can’t calculate the DCF payout ratio yourself or find it on general finance website (therefore we try to mention it in our DSR Stock cards). You must rely on the company’s information found in their quarterly earnings. It requires additional time to establish a trend over several years.
Funds from Operations Payout Ratio
Formula: Dividend per share (DPS)/(Adjusted) Funds from Operation (FFO) per share
Utilization: Real Estate Income Trusts (REITs).
Since REITs are required to distribute at least 90% of their net earnings, the utilization of the adjusted funds from operations (AFFO or FFO) is a more precise metric. Like the payout and cash payout ratio, it’s preferable to look at a long-term trend.
Pros: Similar to the cash payout ratio, you get a clear picture of how much the company has in cash to pay dividends.
Cons: In most cases, you can’t calculate the FFO payout ratio yourself or find it in general finance websites (therefore we try to mention it in our DSR Stock cards). You must rely on the company’s information found in its quarterly earnings reports. It requires additional time to establish a trend over several years.
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